Should you use ‘100 minus age’ rule to decide Portfolio Asset Allocation?

The rule of ‘100 minus age’ to decide investment portfolio asset allocation is a popular and one of the oldest rules for retirement planning.

But unfortunately, it’s a highly misused one too.

And the reason is simple.

The investment world can be quite complex at times and people are constantly on a lookout for shortcuts or thumb rules. And one such thumb rule that is born out of the search for such shortcuts is the much-abused thumb rule of ‘100 minus age’ to get your ideal portfolio asset allocation.

So…

What is the ‘100 Minus Age’ rule of Investing?

It is simple.

If your age is 30, then you invest 100 minus 30 = 70% of your portfolio in equity. Remaining 30% goes to debt.

It basically answers the question about what proportion of your portfolio should be in equity investments.

More examples according to the rule:

Age 35 means 65% can be in equity and 35% in debt
Age 40 means 60% can be in equity and 40% in debt
Age 45 means 55% can be in equity and 45% in debt
Age 50 means 50% can be in equity and 50% in debt
Age 60 means 40% can be in equity and 60% in debt
Age 70 means 30% can be in equity and 70% in debt
Age 80 means 20% can be in equity and 80% in debt

At the face of it, it seems like a reasonable rule to adhere to. But the reality is very different.

This thumb-rule of 100 minus age doesn’t take into account other important factors to arrive at the right equity-debt allocation in a portfolio. And that is why one needs to be careful while using it.

The 100 minus Age rule doesn’t always make sense

The very first thing to note is that the idea is too simplistic.

I am a firm believer of simplicity when it comes to investing. But this rule takes it a bit too far and makes it far simpler than is actually needed.

And that is where it fails.

It simplistically assumes that age is the only factor that should decide the asset allocation and investor’s risk appetite and return needs.

And this assumption is wrong.

Broadly, the rule tries to say that older investors should have a lower allocation to equity. That’s it. This is the broad message. But beyond that, using this formula that is a very big generalization can turn out to be disastrous if followed blindly.

It cannot and should not be applied in all scenarios.

Let us take a few examples to understand why:

Suppose two investors A and B aged 40 are planning their asset allocation. If the rule of 100 minus age is used, then both should have 60% in equity and 40% in debt.

But let’s see what is the real situation of these investors A and B.

Investor A has many dependents – housewife, two school going kids, old retired parents one of whom is scheduled to have a big surgery in coming months, a sister ready to get married in next few years. He also has a running home loan.

Investor B has a working wife, one school going kid and his father runs a successful business. He stays in a home which is fully paid for.

As is easily evident, there is a vast difference between the profiles of both investor A and B even though both are aged 40.

So should they have the same asset allocation?

The answer is no.

Investor A needs a lot of money in the near future (due to parent’s operation and sister’s wedding) and hence, cannot take a lot of equity. He is also constrained by the fact that he is the sole earning member and also has home loan EMIs to pay every month (in addition to school fees of kids). So overall, a very tight situation with a lot of near-term liabilities and scheduled cash outflows. Investing a large proportion of savings in equity can be disastrous for him if markets take a wrong turn.

Investor B on the other hand, is part of a dual income family, with just one school going kid as a dependent. No loan EMIs too. So naturally, he can have a more aggressive asset allocation.

And this is what the problem of 100 minus Age rule has.

It does not give any weightage to the investor’s unique situation.

Robotically reducing your equity allocation just because you’re getting older?

Not the most prudent strategy as people are living longer now and if they have less than adequate amount of equity in their portfolio, they are not going to get the much-needed growth that is imperative to ensure that their portfolio lasts longer than themselves.

The actual asset allocation should also consider factors like the total corpus, its relative size with respect to regular expenses, any scheduled cash outflows for short-term goals. And let us not forget the willingness to take risk as well as the ability to take risk.

Another problem I see in this is that it doesn’t consider the size of investor’s portfolio relative to the regular living expenses.

A 65-year financially independent investor who has a retirement corpus of 45x his annual living expenses and another 5x for regular expenses / liquidity can take a lot more risk than what the formula might tell him.

Isn’t it?

The 100 minus age rule will tell that this investor should have 35% in equity. But I think that if the investor is willing to take the risk, then 35% is too less for such a scenario. The retirement corpus, which is equal to about 45 times his annual expenses, is not needed for his regular expenses (which are handled via the other corpus of 5x). So here equity can be much higher. So in an undervalued market, it can even be as high as 60-70% equity or even more if the investor is comfortable.

What To Do Then?

The “100 minus age” rule is a very general thumb rule. And as highlighted previously, it may not be suitable for everybody of a particular age.

The biggest flaw with the thumb rule is that it puts every individual in an age group in the same box. And that is stupid!

Instead if you are a common investor, then you are better off sticking to the goal-based approach to investing.

Goal-based investing is more scientific, situation-aware and works best when combined with dynamic portfolio strategy to maintain asset allocation.

I have already covered various aspects of it in detail earlier. Some of the links that you may find useful are:

The best part of this strategy is its simplicity. Depending on your risk profile and goal investment horizon, this strategy tells you how much to invest and in what asset allocation for all of your financial goals.

Finally…

As you have seen, the thumb rule of 100 minus age isn’t applicable in all scenarios.

The general idea of the rule is that older you get, will have to depend more and more on your investments for your living expenses and hence you should reduce your equity exposure. But that’s it.

There is no use of this thumb rule beyond that.

Rules of thumb in any case are mere approximations and one should not rely on these rules blindly.

So should you use the 100 minus age rule to decide your portfolio asset allocation?

To cut a long story short, if you’re planning out your asset allocation, then its best to forget this rule.

Find out your financial goals and take the goal-based investing approach.

If you have trouble figuring things out, you can even consult an investment advisor to create a goal based financial plan for you.

It works much better and helps you achieve your financial goals. To be fair, it may not be as simple as these thumb rules but it is far more accurate and increases the probability of goal achievement. And that is something that we all want.